Most tax incentive provisions in the I-T Act are intended to catalyse investments in sectors focal to achieving socio-economic growth targets. Eliminating all extant tax incentives could prove counterproductive. It is imperative that incentives are categorised in the decreasing order of their dispensability.
It is important to anticipate the ramifications of phasing out all tax incentives, before a detailed roadmap is rolled out. Most revenue forgone is accounted for by sectors such as export-oriented units in IT/ITeS and SEZs, and in infrastructure sectors like power, bridges, highways, water treatment and industrial parks.
The I-T Act, at present, provides for a sunset clause for most, if not all tax incentives, and in the recent proposal of CBDT, the government, inter alia, proposed a sunset date for business/activities which at present do not have one—for example, section 10AA providing tax incentives to units exporting out of SEZs. There are key implications that can be anticipated.
Short term: The likely implications of a rate reduction together with a phaseout of tax incentives are based on a static analysis over a 4-year period in which the tax rate will be gradually reduced while the MAT rate remains the same.
* Companies that pay taxes under normal provisions of the I-T Act: Companies that do not claim major tax incentives generally pay taxes under normal provisions. The phased reduction in the base tax rate from 30% to 25% would ordinarily result in lowering the tax liability for such companies, resulting in greater profits available for deployment or distribution as dividends.
* Companies which pay taxes under MAT provisions: In the case of companies that claim large tax incentives/exemptions and are consequently paying tax under MAT provisions, there may not be any immediate change in their tax liability as these companies would continue to pay taxes under MAT provisions, until tax incentives expire or are phased out. During the 4-year period of reduction in the base corporate tax rate, the decrease in net tax rate would correspondingly increase MAT credit for such companies and, consequently, such companies will have excessive accumulated MAT credits.
Once tax incentives are phased out/expire and the eligible company’s tax liability is higher under normal provisions of the I-T Act, such companies will be able to utilise accumulated MAT credits to mitigate future tax liability.
Medium to long term: At present, the ETR of corporates is roughly around 23%, being lower than the statutory tax rate. With the move to reduce the corporate tax rate to about 28% (inclusive of applicable surcharge and cess), complemented with removal of tax exemptions, it may result in an increase in revenue collection and, consequently, an increase in the overall tax burden for the corporate taxpayer.
Considering that tax according to MAT provisions is generally paid by companies claiming tax exemptions or concessions, the efficacy of MAT provisions may need to be re-evaluated in future budgets once tax exemptions are removed. Our view has been that MAT is a regressive tax policy move and should be made applicable very selectively and its continuation when tax exemptions are removed is questionable.
Most tax incentive provisions in the I-T Act are intended to catalyse investments in sectors focal to achieving socio-economic growth targets. Eliminating all extant tax incentives could prove counterproductive, at least in the short to medium term, hampering growth in sectors and geographies which are affected. So, it is imperative that incentives are categorised in decreasing order of their dispensability and a phaseout plan around such order of preference is devised.
The government may find it difficult to do away with locational/geography based incentives, a notable example being incentives offered as part of bifurcation of Andhra Pradesh. It is possible that the ministry of finance may take a fresh look at it, despite the stated intent in its recent press release.
Incentives for the manufacturing sector in the form of accelerated capital write-off are needed to encourage investment, which has been low as a percentage of GDP. Moreover, accelerated depreciation is a timing issue, not necessarily an incremental tax advantage. Tinkering with these basic tenets of the tax incentive regime may not yield much, and can lead to disruptive trends in the sector, besides going against the grain of the Make-in-India campaign and the stability of our tax policy.
Tax rate disparity
The breakup of ETR in the Revenue Forgone Statement for FY2013-14 indicates that the ETR of smaller companies (i.e. companies having PBT up to R10 million) is 26.89% whilst ETR of companies having PBT amounting to R5 billion or more is 20.68%. The reason for the disparity appears to be two-fold.
* There has been a gradual phasing out of profit-linked deductions and the levy of MAT on companies.
* The maximum advantage of proposed tax exemption/concession regime is enjoyed by relatively larger companies.
The proposal to eliminate the tax concession regime may also help bridge the tax rate disparity. Hence, a case can be made out to spare small enterprises from the phaseout exercise.
A welcome consequence in the medium to long term could also be a reduction in disputes regarding tax incentive claims, which form a substantial part of litigation in courts.
CBDT recently rolled out draft proposals for phasing out tax exemptions/incentives; the draft has been put out for public comments. The key highlights of the proposals are:
* Profit-linked, investment-linked and area-based deductions will be phased out for both corporate and non-corporate taxpayers.
* Businesses/activities having a sunset date will not be modified to advance the sunset date. In the case of tax incentives with no terminal date, a sunset date of March 31, 2017, is proposed to be provided either for commencement of the activity or for claim of benefit, depending upon the structure of the relevant provisions of the I-T Act.
* The peak tax depreciation rate will be reduced from 100% to 60% for existing and new assets from April 1, 2017.
* Weighted deduction available to in-house expenditure (including certain capital expenditure)/donation for scientific research will be phased out from April 1, 2017.
* Deductions available in case of expenditure on/donations to eligible social welfare projects or schemes will be phased out from April 1, 2017.
There are a few key takeaways from the draft proposal.
* The proposed roadmap in general is broadly on expected lines, following the announcement in the Budget 2015, and subsequent interactions with business and trade bodies.
* Existing sunset milestones on tax holiday provisions are to be continued, i.e. no rollback and/or extensions are proposed. All other tax holiday provisions, where no defined sunset date exists, will have a uniform sunset date of March 31, 2017. For eligible businesses that begin their tax holiday by the sunset date, the effective period for which companies will enjoy a tax holiday runs into the period 2025-30.
* Rollback from April 1, 2017, of the weighted deduction is in keeping with the overall objective of phasing out incentives, albeit this proposal is a setback for high technology, and research-intensive businesses such as biotechnology, pharmaceutical, IT/ITeS, as the proposal will take away the arbitrage presently available for in-house research and development activities.
* Roadmap for tax rate reduction has been held back and should be announced once proposals have been finalised after taking on board stakeholders.
Evidently, the case for corporate tax rationalisation through a two-pronged approach—rate reduction and phasing out tax incentives—becomes more strategic when viewed from the standpoint of enhancing tax collections and tax-to-GDP trends, without compromising the trade-off which tax incentives facilitate from a socio-economic standpoint.
The draft proposals for rationalisation and withdrawal of tax incentives have attempted to strike a balance between the macroeconomic objective and the need to provide certainty to taxpayers. It is imperative that, in the same vein, the final roadmap for corporate tax rate and tax incentive rationalisation bear the following features:
* There should be a clear timeline for rate reduction, to mitigate any uncertainty or speculative trends in successive rate reduction until corporate tax rates are reduced to the targeted 25%.
* Continue incentivising capital formation in the economy, by allowing accelerated writeoff of capital investment for industrial and infrastructure activities, i.e. manufacturing, and development/operation and maintenance of infrastructure facilities, as it is merely a timing issue, not necessarily an incremental tax advantage.
* Review provision of MAT levy under the I-T Act, and its appropriateness/relevance for corporate taxpayers once tax incentives are phased out in entirety, and the target of corporate tax rate reduction to 25% is achieved.
* Build a business case for continuing incentives for SMEs.
* Identify industries/segments such as IT equipment with export potential and continuously review such manufacturing goods to promote Make-in-India.
* Projects, particularly SEZ development, that are on the drawing board should be viewed independently as they may not be able to meet the notification deadline by March 31, 2017.
* An overall calibration of the phaseout of incentives is recommended, given that tax reduction is calibrated over a four-year period.
* Review the effectiveness of DDT as it affects overall competitiveness.
The author is managing partner, BMR Legal
(Excerpted from the ITRAF paper Protecting and Promoting the Tax Base in India by Mukesh Butani, with contributions from Sumit Singhania, Anuj Agarwal and Shivam Saigal)